REITs: They're not flashy, just profitable

Today's volatile economy is not for the faint of heart, particularly if you are a venture capitalist who has a vested interest in dot-com stocks, or “dot-bombs” as some Wall Street observers refer to them.

As a result of the current economic downturn, even seasoned investors are realizing that it's time to invest with caution. They've learned the hard way that what at first appears to be too good to be true, generally is.

“More and more, institutional investors are coming to grips with the fact that the kinds of 20% to 35% annual returns they had grown accustomed to in the large-cap, large-growth stocks are unlikely to be seen again for some time,” said Michael Grupe, vice president and director of research for Washington, D.C.-based National Association of Real Estate Investment Trusts (NAREIT).

“If investors revise down their total return expectations closer to the long-run historical averages for equities in general, suddenly the importance of dividends and income are relative to the importance of capital appreciation increases.”

Opportunity for REITs

REITs scored a turnaround in 2001, according to Moody's Investors Service, which predicts stability in the REIT sector for the remainder of the year.

Like all areas of the economy, REITs are affected by the stock market's current bear status. But with a strong demand for all types of real estate, the industry as a whole is “well-positioned” for a soft landing, according to Moody's.

These ideas highlight the pluses of investing in REITs, which fell to the back burner when tech stocks were in the limelight the past few years, according to Grupe. “With a REIT, you're getting dividends upfront. Every time you get that dividend payment, it's no longer a risky return. You have it in your hand, in your pocket,” Grupe noted.

Office blues

The office market has been scarred by the trends in the overall economy, particularly because of the dot-com and technology stock fallout. Once dot-com hotbeds, California cities such as San Francisco, San Jose and Oakland are witnessing considerable softening in their office markets, as have areas in other dot-com meccas including Atlanta, Seattle, Washington, D.C., and Austin, Texas.

Through the first half of 2001, available office space in San Francisco tripled from 2.4 million sq. ft. to 7.8 million sq. ft., according to New York-based Cushman & Wakefield. Leasing activity in the city registered 2 million sq. ft. through June, just 25% of the amount recorded during the same period in 2000, and 1 million sq. ft. less than the mid-year average of 3 million sq. ft. of leasing activity during the past seven years.

“What I've read is that the collapse of the tech bubble [in markets such as San Francisco, Austin and suburban Washington, D.C.] has led to an increase in sublease space coming on to the market,” said Grupe of NAREIT. “Some of those young companies that leased space failed, and they have no need for the space or can't afford it. So, they're walking away, going bankrupt and the owner of the space gets it back, or the current tenant may sublease it in order to pull off some sort of economic value.”

Many of the tech companies leased Class-B or Class-C+ office space, Grupe noted, but most office REITs in large metropolitan areas don't own a high concentration of such properties. These REITs won't suffer as much as companies that possess concentrated supplies of Class-B and Class-C office space, Grupe added.

Mitchell Hersh, CEO of Mack-Cali Realty Corp. based in Cranford, N.J., agrees. “No one in the office sector benefits from an economic slowdown. Some tenants are taking longer to make decisions, and vacancy rates are clearly rising in some markets,” Hersh said. “But well-positioned REITs will be less affected by such cycles.”

Mack-Cali strengthened its position during the past year by disposing of assets in “non-strategic” markets and bulking up its portfolio in markets with high barriers to entry in the Northeast region. Mack-Cali, a REIT providing management, leasing, development, construction and other tenant-related services for its Class-A real estate portfolio, owns or has interests in 267 properties, primarily office and office/flex buildings, totaling 28.2 million sq. ft.

Properties in non-strategic markets that Mack-Cali has sold during the past year include:

the Brandeis Building, a 319,500 sq. ft. office building in Omaha, Neb., for $12.5 million, to TCI Brandeis LP;

the 71,000 sq. ft. Cornerstone Regency office building in Houston, for $3.15 million, to Cornerstone Northchase Venture LP; and

the Tetco Towers, a 256,137 sq. ft. office property in San Antonio, Texas, for $21.9 million.

Over the next two years, Mack-Cali plans to sell an additional 4.9 million sq. ft. of office assets in several markets, including Dallas, Houston, Denver, Phoenix and San Antonio. Proceeds from these sales will be re-deployed into the company's Northeast and Mid-Atlantic properties.

In March, Mack-Cali announced it was breaking ground on a 575,000 sq. ft. Class-A office building on the Hudson River waterfront in Jersey City, N.J., with the entire space pre-leased to Charles Schwab & Co.

In May, Mack-Cali leased more than 208,000 sq. ft. of new and renewal space at its New York and Connecticut office properties. Among the high-profile tenants are Toyota Motor Credit Corp., Varta Batteries, Fujitsu Network Communications and Trigen Energy Corp. And in June, Mack-Cali reported that 150,000 sq. ft. of its New Jersey office space had been leased.

The company's strategy appears to be working. Total revenues for the first quarter of 2001 increased 2.4% to $146.5 million, compared with $143 million during the same period in 2000.

“A REIT's markets, tenant base and diversity, and asset quality all enter into the mix,” Hersh said. “Those that have focused their growth in markets with high barriers to entry, in which a balance of supply and demand exists, are usually best positioned,” according to Hersh.

“Since the markets haven't been overbuilt, rents have remained competitive and vacancies have remained strong, resulting in more stability and less effects from the swings in the cycles. Also, long-term leases with high credit-quality tenants from a variety of industries ensure a healthy degree of earnings stability,” Hersh added.

Volatile retail market

The 2002 outlook for the retail sector by analysts isn't healthy. In fact, it's downright gloomy. Moody's gave retail a negative rating and said declining consumer confidence and corporate layoffs will mar the retail industry. Loosely translated, this trend places downward pressure on rents and occupancies.

“In 2000, we had an unprecedented volume of tenant bankruptcies, which has caused us to really be much more pro-active in anticipating the situations in re-leasing space, even before we get it back so as to eliminate the down time,” said Scott Wolstein, president and CEO of Developers Diversified Realty (DDR).

The Cleveland-based REIT owns and manages more than 240 shopping centers totaling more than 57 million sq. ft. of property in 41 states. “We've had to be much more aware and in tune to the credit-worthiness of the various tenants further in advance than we've been in the past to make sure that we're prepared in the event that there's a Chapter 11 or Chapter 7 filing,” Wolstein said.

Throughout 2001, DDR has weathered the ups and downs of the economy by doing everything within its power to maximize asset value on a long-term basis. Specifically, DDR has pruned its holdings in “non-core” markets.

In April, DDR sold a 35,500 sq. ft shopping center in Rapid City, S.D., to a private investor for $2.35 million. Then came the sale of two non-core shopping centers in Ohio for $42.2 million and a former Best Products site in El Paso, Texas, for $1.9 million.

Leasing for the company continues to be strong. In the first quarter of 2001, DDR executed 61 new leases for approximately 247,000 sq. ft. at an average rental rate of $15.02 per sq. ft., an 18% increase over prior rental rates. The company also completed 133 lease renewals. For the first quarter of 2001, DDR reported that funds from operations (FFO) were $0.58 on a per share diluted basis compared with $0.54 per share for the same period in 2000.

“Niche marketing” is a concept that Scott MacDonald, president and CEO of CenterAmerica Property Trust, said has helped his privately held REIT to fend off the current economic slump. The Houston-based umbrella REIT owns and operates more than 100 neighborhood shopping centers throughout the Sunbelt, including Texas, Florida, Louisiana, Mississippi, New Mexico and North Carolina — all areas awash in suburban growth.

By concentrating on neighborhood retail centers, CenterAmerica is less prone to the vicissitudes of retail trends affecting regional malls, MacDonald said. Shoppers will always have a need for food, ensuring CenterAmerica's survival, MacDonald emphasized.

Rather than solely invest in new construction, the company has put a lot of effort into the redevelopment of its existing properties. CenterAmerica has renovated 25% of its properties since 1995. Currently the REIT has about 20 projects in redevelopment, including two major projects in Satellite Beach and Stuart, Fla.

The neighborhood shopping center industry is not completely immune to the ebb and flow of the broader economy, MacDonald said. CenterAmerica properties confront issues such as tenant bankruptcies and chain store closings. “It's not fun while it's happening, but once it's done, you realize you're better off for it,” MacDonald said.

Regional mall giant Simon Properties of Indianapolis appears undaunted by the current economic slump. “Compared with other REITs, retail has done very well. For the second quarter of 2001, the retail sector led all REITs in total returns,” said Mike McCarty, senior vice president of Simon's corporate communications. “Within the retail sector, the regional mall group far outpaced the neighborhood centers and factory outlets.”

In the first quarter of 2001, Simon's FFO increased to $0.74 per share, up from $0.71 per share in 2000. Total revenue rose 2.7% to $490.7 million as compared with $477.9 million during the first quarter of 2000. As of March 31, the occupancy rate at Simon malls stood at 90.2% compared with 89.5% in the first quarter of 2000.

“Well-capitalized and well-run retail REITs will be able to execute their business plans over the near term without having to pursue risky projects in order to fuel growth,” McCarty said. “At the same time, these companies should keep their eyes fixed on the markets, looking for opportunistic situations that often surface in times of economic uncertainty.”

Multifamily shines

Consider the multifamily industry the golden child of today's REIT world. It has everything going for it. After all, everyone needs somewhere to call home.

“People are always going to need a place to live, and most people are going to pay their rent or mortgage payment before they pay any other bills,” said Barbara Hasenstab, vice president of investor relations and corporate communications for Associated Estates Realty Corp.

Based in Richmond Heights, Ohio, the REIT directly or indirectly owns, manages or is a joint venture partner in 129 multifamily properties containing 31,334 units located in 14 states. Hasenstab said that the recent economic climate has actually increased demand for multifamily housing.

“There are basically two types of renters: renters by choice and renters by necessity. While a low interest rate environment may allow more renters by necessity an opportunity to become homeowners, factors such as the economic uncertainty, an increasing number of household formations, aging Baby Boomers and supply constraints are still creating a strong demand for apartments,” Hasenstab said.

And that demand has translated into monetary growth for Associated Estates. The company reported total FFO of $6.18 million in the first quarter of 2001 compared with $5 million for the same period a year ago, an increase of 22.4%. Total revenue for the quarter was $39.6 million compared with $38.28 million during the same period a year ago.

Geographic expansion is one of the main objectives of Associated Estates. Currently, more than 75% of the company's portfolio includes properties in the Midwest. Associated Estates has decided to reduce that figure to 50% in order to concentrate on growing the portfolio in Atlanta, metropolitan Washington, D.C., and Florida.

Projects outside its Midwest region include the newly constructed 460-unit Windsor at Kirkman in Orlando, Fla., which was 89% leased at the end of the first quarter. In March, the property was a recipient of the “Pillars of the Industry Award” in the “Best Leasing Center” category, sponsored by the National Association of Home Builders Multifamily Division, the Urban Land Institute and the Mortgage Bankers Association of America.

Douglas Crocker, president and CEO of Chicago-based Equity Residential Properties Trust, shares Hasenstab's optimistic outlook for the multifamily REITs and the apartment industry in general.

“While the slowdown in the economy has hurt different markets greater than others, the [multifamily] industry is very strong on a reactive basis. We are not in an overbuilt situation in many markets,” Crocker said. “We have witnessed a slight uptick in vacancies and a slowing in rental growth, but the market is still healthy.”

Jeff Gould, president and COO of BRT Realty Trust, a Great Neck, N.Y.-based direct lending company that originates short-term acquisition and bridge loans, said the multifamily sector will remain strong as long as inexpensive financing proceeds remain available. “There are many lenders looking to do more conservative lending with a stable commodity, that being multifamily apartments, and this should continue for some time,” Gould said. Additionally, there has been an ever-growing appetite to convert multifamily garden apartment properties to condominiums, Gould said.

Industrial demand still strong

The industrial REIT arena hasn't been immune to the softening economy either. Many manufacturing companies utilizing industrial space have cut back demand for industrial property or have shut down operations, leaving behind noticeable vacancies.

Gould of BRT Realty Trust, which also finances industrial projects, said the good news is that there has been strong demand to fill those vacancies.

Moody's REIT report indicated that while industrial spaces are susceptible to the same economic effects as the office, retail and lodging areas, the problems facing the sector are comparatively less severe. Nevertheless, industrial properties catering to research and development space also may experience negative effects from the technology slump.

Despite that forecast, major industrial projects are being planned and delivered, including the 400,000 sq. ft. Montebello Metro Center, an industrial complex in central Los Angeles under construction by Atlanta-based IDI.

Conclusion

The REIT market managed to end 2000 on a much higher note than many of its publicly traded counterparts, and insiders are expecting the same for 2001

“We're seeing a continuation of a refocusing of the institutional investor community on issues having to do with risk management, asset allocation and investment diversification,” said Grupe of NAREIT. “I think those [bullet points] work positively for some of the sectors that had largely been out of favor when tech stocks were so popular.”

Stephanie Sonnenfeld is an Atlanta-based writer.

Arden Realty Corporate Profile

For Arden Realty, Southern California's largest office landlord, having key relationships, a focused strategic plan and thorough expertise in its own backyard have been critical elements for keeping a solid foundation throughout the real estate cycle. With 140 office properties comprising approximately 18.7 million square feet in 45 submarkets, Arden's ability to concentrate its growth in a single region has enabled the company to keep a close ear to the ground and anticipate, rather than react to, shifts in the market. Arden has also stayed closely attuned to the evolving needs of its core tenant base, as opposed to adapting to “New Economy” trends, a fact that has resulted in less than 1% of its tenant roster being represented by dot-com companies.

A development that exemplifies the benefit of Arden's targeted regional focus is the company's Howard Hughes Center, a 70-acre, mixed use business campus in West Los Angeles that blends 1.75 million square feet of completed office space and build-to-suit opportunities with extensive landscaped park areas, water elements and greenbelts. Complementing the Center's significant office component is a 5.7-acre retail complex with shops and a wide range of restaurants as well as a deluxe 18-screen theater, owned and operated by the J.H. Snyder Co. Arden also has a potential for 600 rooms on two different available hotel sites. When completed, Howard Hughes Center will provide a city-within-a-city service and office space environment spanning 2.7 million square feet that provides a “business village” unprecedented in the region.

At the time that Arden purchased the property from Summa Corp. in 1998, their plan for the development was somewhat contrarian. Futurists were predicting that increasingly, the typical American employee would be a tele-commuter with at least 20 working hours conducted in a home office and the farthest commute, a trip to the refrigerator. Today, however, the trend toward working at home has dwindled even as computer capability has increased. Employees are seeking peer interaction and a community context, but beyond that of conventional office parks in remote suburbs or a high-rise squeezed into a CBD. Howard Hughes is virtually the only business campus of its kind in a strategic, highly visible urban location adjacent to the region's busiest interstate thoroughfare — the 405 Freeway.

To date, the market has responded enthusiastically. Arden developed a 160,000 square foot build-to-suit for one of the nation's leading Hispanic broadcasting companies, Univision Communications Inc., which will be occupied in the fourth quarter of 2001. Significant pre-leasing has taken place as new space has broken ground. Entertainment software giant Vivendi Universal Interactive expanded its existing office space at the center with two additional floors at one of the recently completed buildings. Vivendi has targeted over 1,000 employees to be settled into its new offices at the center by October. In addition, significant interest among several credit tenants is being generated for Arden's most recent 280,000 square foot building under construction that will be completed in 2002 with a target stabilization date of second-quarter 2003. Arden is actively marketing available office space and the two build-to-suits.

The continuing success of the Howard Hughes Center reflects the fact that Arden's growth is divided between a wide range of strategies apart from just acquiring, leasing and managing existing real estate. For Arden Realty, this means developing select, strategic property in the markets it knows best and providing a development prototype that will not only generate revenue, but also shape the design of future mixed-use developments for years to come.

General Growth Properties Corporate Profile

Beginning in 1954 as a private enterprise of Matthew and Martin Bucksbaum, General Growth is now a successful public REIT with a total market capitalization of nearly $7 billion. Listed on the New York Stock Exchange since April 1993, GGP has achieved uninterrupted consecutive quarterly FFO growth. FFO per share has increased approximately 16% on a compound annual basis, with dividend payout rising 38% since the Initial Public Offering.

With a historically strong FFO, consistent dividend increases, and a 5+% dividend yield, GGP provides an attractive mix of growth and income potential. Thecompany is a leader in maximizing mall profitability and boosting its returns.

Corporate vision and mission

At General Growth Properties, our vision is to be a “customer built” company, giving our core customers what they want, when they want it, and where they want it. We are custom-built and customer-focused on four key audiences: consumers, owners, retailers, and employees.

The corporate mission of General Growth Properties is to create value and profit by acquiring, developing, renovating, and managing regional malls in major and middle markets throughout the United States. The company provides investors with the opportunity to participate in the ownership of high-quality, income-producing real estate, while at the same time maintaining liquidity. Our primary objective is to provide increasing dividends and capital appreciation for our shareholders.

In an effort to succeed in our mission of increased growth, GGP maintains an aggressive acquisition and redevelopment pipeline. In the first eight months of 2001 alone, two malls have been added to the portfolio in Arizona and Texas, respectively. Both malls represent a dynamic market presence for GGP in the Houston and Tucson metro areas. With regard to the expansion and renovation of existing properties, approximately 14 malls are in the process of being updated, which will add nearly 1.4 million square feet of new retail space.

In addition, General Growth owns one of the most successful regional malls in the world, Ala Moana Center. Considered the “crown jewel” of Pacific Rim retailing, the open-air center, located in Honolulu, features the leading haute-couture stores and boasts over $1 billion in annual sales.

General Growth Properties Inc. is one of the nation's largest shopping center owners, managers and developers. General Growth currently has ownership interest in, or management responsibility for, a portfolio of 145 regional shopping malls in 39 states. The company portfolio encompasses approximately 125 million square feet of retail space and includes more than 15,000 retailers nationwide.

Andersen Corporate Profile

Andersen is a global leader in professional services. It provides integrated solutions that draw on diverse and deep competencies in consulting, assurance, tax, corporate finance, and in some countries, legal services. Andersen employs 85,000 people in 84 countries. Andersen is frequently rated among the best places to work by leading publications around the world. It is also consistently ranked first in client satisfaction in independent surveys. Andersen has enjoyed uninterrupted growth since its founding in 1913. Its 2000 revenues totaled $8.4 billion (U.S. dollars).

Real estate and hospitality is one of the firm's leading industry concentrations, serving more than 5,000 clients worldwide. The group, which includes some 5,800 professionals in 80 offices around the globe, provides a full range of real estate advisory and financial services to corporations, institutions, real estate investment trusts, developers and owners/operators. It maintains active leadership in issues significant to the industry through our participation in national trade organizations, including the National Association of Real Estate Investment Trusts (NAREIT), Urban Land Institute (ULI), National Association of Corporate Real Estate Executives (NACORE), Hospitality Finance and Technology Professionals (HFTP) and Building Owners and Managers Association (BOMA), among others.

In addition, real estate and hospitality publishes extensively to support the timely exchange of leading-edge thinking and best practices in the industry through a continuing series of research papers and journals.

Arden Realty, Inc. [NYSE:ARI] is a self-administered and self-managed real estate investment trust (REIT) that is the largest office landlord in Southern California, with 140 properties and approximately 18.4 million square feet of office space. For the past two years the Environmental Protection Agency cited Arden as the “Commercial Real Estate Owner of the Year” for its innovative energy initiatives and for owning the most energy efficient buildings in a single portfolio in the nation. Visit the company's web site at www.ardenrealty.com.

General Growth Properties is one of the nation's largest shopping center owners, managers and developers. General Growth currently has ownership interest in, or management responsibility for, a portfolio of 145 regional shopping malls in 39 states. The company portfolio totals more than 125 million square feet of retail space and includes over 15,000 retailers nationwide. A publicly traded Real Estate Investment Trust (REIT), General Growth Properties is listed on the New York Stock Exchange under the symbol GGP. For more information on General Growth Properties and its portfolio of malls, please visit the company's web site at www.generalgrowth.com.

Andersen is a global leader in professional services. It provides integrated solutions that draw on diverse and deep competencies in consulting, assurance, tax, corporate finance, and in some countries, legal services. The company is consistently ranked first in client satisfaction in independent surveys. Learn more at www.andersen.com.